Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New David Einhorn (best classic books of all time .TXT) 📖

“What is the SEC doing about this? Why can’t they figure this out? Why didn’t The Wall Street Journal jump all over this?”

By the end of the meeting, he said, “I’m going to do it, but I want an exclusive.”

“Sure,” I said. “That’s not a problem.”

He told us that reporting this sort of story takes a long time, but promised that if the facts checked out, he would definitely write it. I left the meeting thinking that we would see something in about six months.

Months went by . . . nothing. At Eichenwald’s request, we kept sending more documents and updates as the story progressed, and he kept enthusiastically expressing that he wanted all the information. Eichenwald claimed he was working on it, but none of the sources we’d suggested he contact said he had called. Not a good sign.

CHAPTER 21

A $9 Million Game of Three-Card Monte

Sometimes, revealing events come from the most insignificant places. Jim Brickman, the retired real estate developer from Dallas who had continued to independently research Allied and BLX, found one of those places in early 2004.

He had been digging through court records of the bankruptcy proceedings of bad BLX loans. In the bankruptcy of a convenience store called Trilogy Conifer in Colorado, lawyers for Allied, rather than BLX, had oddly showed up in court to collect on the loan. Allied told the judge that it owned the loan and submitted the proof to the court. It was a short, but revealing, document: Allied told the court that BLX assigned Allied ten loans, including this one, with balances of $9,062,489, in exchange for Allied forgiving the same amount of BLX’s debt to Allied. The document, dated February 3, 2003, was signed by Sweeney for Allied and by Tannenhauser for BLX. Why would Allied accept a defaulted loan from BLX for full value? Were the other loans in similar shape?

Brickman and I tried to get information on the ten loans. Several appeared on BLX’s August 2001 delinquency report. We were able to find nine of them and all defaulted long before BLX assigned the loans to Allied in February 2003. A look at the court records clearly showed that these were not only troubled loans, but that there was no way anyone other than Vito Corleone could have expected repayment.

Why did Allied accept these loans? My first instinct was to believe they did it to mask BLX’s deteriorating situation. As Allied valued BLX at a minimum of eleven times earnings, a $9 million loss at BLX translates to a $99 million valuation loss for Allied. So shifting the loss from BLX to Allied enabled Allied to value BLX $99 million higher. In contrast, if Allied owned the loans, it would only be a $9 million loss on its books. Table 21.1 lists the transferred loans.

Table 21.1 Bad Loans Transferred to Allied

 CompanyAmountAu Gres Pinewood Inn, Best Western Pinewood Lodge$1.0 millionAvant-Garde Enterprises$0.4 millionDibe’s Petro Mart$1.0 millionFarmer House Foods and XTRA Foods and Orchard Food Center$1.0 millionFederal One Stop and William Grossi$1.0 millionThe Kelfor Companies$1.1 millionThe Learning Center at Birch Run’s Playpark$1.0 millionThe Links at Birch Run’s Playpark$1.0 millionTrilogy Conifer$1.0 million1750 Woodhaven Drive and the ATS Products Corporation$0.5 million

In the Trilogy Conifer bankruptcy in 2002, the company already owed Allied $1 million on a promissory note from December 1998. As of August 2003, Allied was owed $1.2 million, but was second in line to BLX, which was owed about $1.1 million plus legal fees and costs on an apparently separate loan.

In a legal proceeding Trilogy filed against Allied, Trilogy claimed that Allied’s representative prepared projections that “overstated revenues and understated expenses, with the result that the unachievable debt service was made to appear reasonable and achievable.” According to Trilogy’s complaint, Allied increased the 1998 loan amount by another $135,000 on August 16, 2000, at a time when “it knew or should have known that the projections of profitability were not possible.” The complaint further adds, “[t]he loan balances were far in excess of a reasonable debt load for such a convenience store operation.” The complaint alleged, “Allied purposefully pursued a pattern and practice of making loans to gas station proprietors that it knew could not service the heavy debt.” Allied later settled the case on undisclosed terms.

The other loans each had its own story—all bad. Most were in bankruptcy, but some had been discharged from bankruptcy; that is, there wasn’t anything more to be done to collect on them. Yet, Allied paid BLX full value for them.

Meanwhile, Allied’s stock had performed strongly since April 2003, reaching $31 a share in February 2004. When Brickman posted these findings about the loans and links to the source documents on the Yahoo! message board, Allied stock quickly fell a few percentage points. Allied, as far as I could tell, did not disclose this transaction to shareholders. I found no mention of the loan transfers in any of Allied’s filings with the SEC.

Allied’s poor investments continued to pile up. Two more companies to which Allied loaned money filed for bankruptcy protection. Each bankruptcy filing provided a fresh example of Allied’s failure to mark down loans as they deteriorated.

Executive Greetings filed in December 2003. Allied invested $16 million in subordinated debt and warrants in 1999. In early 2002, Executive Greetings either stopped or reduced its interest payments to Allied. Despite this, Allied carried the investment at cost through September and continued to accrue non-cash or PIK income throughout 2002 (see Table 21.2). According to Executive Greetings’ plan of liquidation, the company lost one-third of its revenues and more than half its earnings between 1999 and 2002. Plainly, the lack of interest payments and deteriorating results were evident long before the end of 2002. According to the bankruptcy records, Allied held a junior loan that would receive “little or no distribution.”

Table 21.2 Executive Greetings

In February 2004, Garden Ridge filed for bankruptcy. In 1999, Allied had invested $28 million in subordinated debt and equity in the retailer.